globalised world is, in many ways, a smaller world. When shoppers scour the grocery store aisles in San Francisco, Sydney or Seoul, they may be purchasing different food items, but these days they are suffering from the same sticker shock. Whether due to drought in Australia or an ethanol boom in the US, the effects on food prices are felt in all corners of the world.

In China, soaring food prices have driven inflation to their highest levels in more than a decade, straining household budgets in the world's most populous country. Dramatic price increases have been chalked up to an unfortunate confluence of factors – supply problems endemic in China's pork industry, an outbreak of “blue ear” disease on pig farms and to drought and flood-related price hikes. But behind these events, a host of structural problems are contributing to higher prices.

China feeds 22 per cent of the world's people with only 7 per cent of its farmland and must do so with a poor endowment of agricultural resources. Compounding matters, China's per capita water supply amounts to just a quarter of the global average and is unevenly distributed. A host of daunting challenges suggests that the country's agricultural productivity must pick up dramatically to keep pace with the changing nature of food demand.

A wealthier generation of Chinese consumers is shifting from traditional meals to a diet heavy in meat, eggs and dairy products. China's urban population – which is growing by 15m-20m people a year – consumes three times more meat than the rural population.

This ratio has tremendous implications for the country's grain consumption: 70 per cent of China's corn and soyabeans and about half of the country's sweet potato supplies go towards feeding livestock. It takes 5-7kg of grain to produce 1kg of pork – the country's staple meat. Since 1990, China's feed industry has increased its annual output by an average of 18 per cent a year to supply the country's livestock farms.

In the midst of surging demand, a recent initiative to encourage the use of less polluting biofuel has inadvertently created an alarming source of competition for grain. China's ethanol producers ramped up production of corn-based ethanol, consuming an increasing portion of the country's annual corn output. Recognising the threat to food security, China has suspended new approvals for corn-based ethanol projects, instead promoting a shift to biofuel production based on crops like cassava and sorghum.

Since farmers adjust crop allocations to take advantage of higher prices, it is easy to dismiss swings in the supply and demand balance of grains as short-lived phenomena.

But where China is concerned, self-sufficiency in grain has been achieved through frequent policy intervention and an increasing burden of subsidies to keep more farmers from switching to cash crops. When such distortions are removed, the results can be dramatic. As restrictions against importing soyabeans were gradually lifted in the 1990s, China made a rapid transition from being a net soyabean exporter to the world's largest importer within several years.

Looking ahead, we expect China will aim to remain self-sufficient in food grains like rice and wheat, while importing more feed grains. China may soon become a net-importer of corn for the first time in a decade to make up for a domestic shortfall in supply.

Meanwhile, big initiatives are being undertaken to modernise China's agriculture. The $20bn south-to-north water transfer project is one example. In the years ahead, we expect improving farm incomes and rural education initiatives to propel demand for organic fertiliser and advanced irrigation systems. The government may also allow the commercial cultivation of genetically modified food crops.

As 1.3bn Chinese consumers move up the ladder of prosperity, extraordinary changes are occurring in China's agricultural trade and domestic food economy. China's success in resolving its agricultural limitations will go far in determining whether higher food prices are here to stay – not just in China, but across global markets.